Mutual Fund News

Canadian fund managers who owned Sino-Forest Corp. shares are growing increasingly wary of North American-listed Chinese stocks, but not all have given up on the sector or the controversial forestry company.

Many funds have quietly sold their stock in Sino-Forest after Muddy Waters Research, a firm founded by short seller Carson Block, suggested on June 2 that the company had inflated the size and value of its forestry assets. Those allegations have sent Sino-Forest's share price, which was as high as $25.85 in March, to below $3 on the Toronto Stock Exchange.

However, Jim Huang, president of T.I.P. Wealth Manager Inc., said he is still hanging on to his battered Sino-Forest stock until he gets more clarity.

"I don't believe there is conclusive evidence one way or another that Sino-Forest is a fraud," said Mr. Huang, who manages JOV Prosperity Canadian Equity and other funds. "But clearly, Sino-Forest has things they need to clarify and disclose."

"China is a market with huge potential, but it is also a market where things are not done the same way as [they are] done in the West," said the Shanghai-born fund manager. "They are done based on handshakes, connections and relationships, and not necessarily everything is documented. It's like the Wild West."

That creates uncertainty that many fund managers are not prepared to face. Alex Sasso, chief executive officer of Hesperian Capital Management Ltd., said he is not ruling out investing in Chinese firms, but has become more cautious. His firm sold about half a million Sino-Forest shares in several Norrep funds just after the report was released.

"I was very shocked," recalled Mr. Sasso, who has owned Sino-Forest in his small-capitalization funds since about 2005. "When we started to dig into it a bit, we thought we had to protect our clients' capital.

"You get a little more skeptical after a situation like this," Mr. Sasso added. "On one hand, you have phenomenal opportunity for growth given that [China] is one of the fastest[-growing] economies in the world, and on the other side, you have to weigh the rewards versus the risks."

Sino-Forest is among many Chinese companies that listed on North American exchanges using a back-door method, known as a reverse merger. By acquiring a shell company with a stock-market listing, reverse-merger companies avoid the scrutiny required in initial public offerings (IPOs).

While an independent committee of Sino-Forest's board of directors has hired accounting firm PricewaterhouseCoopers to investigate allegations made by Mr. Block, and plans to report its findings in two to three months, many investors are not sticking around for answers.

U.S.-based O'Shaughnessy Asset Management LLC, which runs funds for Royal Bank of Canada, is banning reverse-merger companies from its universe of potential investments after discovering that its Canadian and U.S. stock funds owned two Chinese firms, Sino-Forest and Puda Coal Inc., that have been accused of fraud this year.

While the investment firm recently dumped its Sino-Forest shares, it has not been able to sell Puda Coal because the U.S.-listed stock was halted in April after allegations the company's chairman transferred ownership of its main subsidiary to himself without shareholder approval.

Eric Yan, a portfolio manager with Matrix Fund Management Inc., had already been cautious about investing in North American-listed Chinese companies because he says the motivation for many of these firms to list overseas is because they can't get approval to do so in China or Hong Kong.

"Sino-Forest was an exception because it had been audited many, many times, had a very long track record, and was a $5-billion company," said the manager of an Asia-Pacific equity fund.

"Once the [Muddy Waters] report came out, I dumped all my stock given the huge uncertainty."

While Sino-Forest's biggest investor, U.S. hedge fund manager John Paulson, recently sold all of his shares, some Canadian-based firms such as Mackenzie Financial Corp., DundeeWealth Inc., which runs the Dynamic brand funds, and Fidelity Investments Canada, won't say whether they still own or have sold their shares in the controversial company.